When To Sell A Stock (Even One You May Love)

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Includes: AIRT, AMZN, HSIC, NTRI, OMI, PETS
by: John DeFeo
Summary

Knowing when to sell a stock can be harder than knowing when to buy.

There are times when even beloved stocks must be sold.

Valuation alone is a debatable reason to sell a stock.

If I look back at my investing mistakes (and I've made several), it's clear that I have more regrets about selling stocks than buying them. That's why I keep a portfolio of 40 dividend growth stocks that I never plan to sell. It gives me a way to remove my emotions from my investments and, maybe, if I'm lucky, to hold on to something special.

This passive investing strategy was inspired by the market-beating Corporate Leaders Trust Fund (LEXCX), which hasn't changed its stock holdings since it was founded in 1935. Talk about buy and hold!

Although I buy most stocks with the intention of holding them for a very long time, I've sold several stocks recently without regrets (even as some of them have climbed higher). Here are my reasons for selling:

  • Change of company policy or strategy;
  • Conflict with my own morals or values;
  • Initial investment thesis was wrong;
  • Stock is flatlined because of pending acquisition;
  • Legitimate fear of competition;
  • Tax-loss harvesting; and/or
  • Better investment opportunity elsewhere.

I'll explain each of these reasons along with real examples of stocks that I've sold. But just because I sold these stocks doesn't mean they aren't a sound investment for someone else.

Change of Company Policy or Strategy

Air T, Inc. (AIRT) used to be a predictable air freight company. They made small-plane deliveries for FedEx (FDX) and sold de-icing products to airports and other fleet owners. I bought the stock because it was an easy company to analyze and it paid a decent dividend. That changed after the company became the target of competing activist investors. One of those investors, Nick Swenson, took over as CEO. He eliminated the dividend (boo!), but the shares rocketed higher because of operational improvements (yay!). Still, Swenson is an investor at heart and his ambitions seem bigger than air freight. The company began investing in unrelated businesses, like digital printing and signage. That's when I bailed. I bought my shares because I was looking for a simple business with a decent dividend, not because I was looking for the next Berkshire Hathaway (NYSE:BRK.B).

Conflict With My Own Morals or Values

I bought shares in Nutrisystem (NTRI) when no one wanted to touch it. The company had management issues and worsening fundamentals. Then, the black cloud lifted and shares bounded higher. I should have been happy, but I had a nagging feeling: I didn't like the company's advertising. It seemed heavy-handed (e.g. "Lose 15 lbs. & 7 inches overall in your first month!"). I'm not the only one who felt that way, so I waved goodbye.

Initial Investment Thesis Was Wrong

I've bought stocks, or resisted buying stocks, because I made a formula error in a spreadsheet that gave me an incorrect valuation. I don't make mistakes like this often, but when I discover one, I fix the mistake and take action based on true and accurate data.

Stock Is Flatlined Because of Pending Acquisition

When a company is going to be acquired, its shares usually pop higher on the news, then trade sideways until the market price of the stock gradually nears the price at which the stock will be acquired. This happened when Merck KGaA offered $140 per share for Sigma-Aldrich stock (which was trading at $102 at the time of the announcement). I sold my shares of Sigma-Aldrich for $139.60, rather than wait for the deal to close, and used the proceeds to buy shares of Quaker Chemical (KWR). Those Quaker shares appreciated by 2.6% between the time I bought them and when Merck finally acquired Sigma-Aldrich.

Legitimate Fear of Competition

PetMed Express (PETS) is another stock that I bought when nobody wanted to touch it. I bought more and more shares because the cash-flow yield and the dividend were so high. This eventually became my largest stock holding and the best investment I ever made, growing in value by several hundred percent (always reinvest your dividends, if you can!). Then I sold it all because Amazon (AMZN) spooked me. The pet care industry is worth nearly $67 billion and there is no single company that dominates that huge market. Amazon could be that dominant company if it wanted to be. I took my chips off the table and wish the company well.

Tax-Loss Harvesting

I recently sold shares of Houston Wire & Cable (HWCC) at a loss and used the proceeds to buy shares of Ensco (ESV). Now I can take the capital loss without giving up what I had: shares of a beaten-down company that relies on a single commodity. Copper and oil are unrelated businesses, so I'm able to declare a capital loss without triggering a wash-sale (the rule that prevents tax abuse from moving money at a loss between substantially similar investments). I can't claim victory yet, though. Houston Wire & Cable has rebounded since I sold it (doh!).

Better Investment Opportunity Elsewhere

Sell what is cheap to buy what is cheaper. This makes sense, but it's a hard thing to do psychologically. I recently sold shares of Henry Schein (HSIC) to buy shares of Owens & Minor (OMI). Maybe time will prove that this was a foolish move: Henry Schein is a great company selling for a fair price, but my math says that Owens & Minor is the better deal now.

Conclusion

Besides the points above, there aren't many reasons that I'd sell a stock that I bought with the intention to hold for a very long time. Have I sold stocks because I thought they were overpriced? Sure. Those are the sales that I regret because I've parted with amazing companies that just kept growing.

Again, I'm not trying to convince anyone to sell (or refrain from buying) any of the stocks I mentioned in this article. They may all turn out to be exceptional investments. On the other hand, I do hope this article has convinced you to look at your own portfolio on occasion and to see if it reflects your expectations and principles.

Disclosure: I am/we are long ESV, KWR, OMI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.